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CASE 2: USEFUL LIVES ARE DIFFERENT AMONG THE ALTERNATIVES

1.) THE REPEATABILITY ASSUMPTION Conditions: 1. Study period is either indefinitely long or equal to a common multiple of the lives of the alternative. 2. The cash flows associated with an alternative's initial life span are representative of what will happen in succeeding life spans. EXAMPLE: The following data have been estimated for two mutually exclusive investment alternatives, A and B, associated with a small engineering project for which revenues as well as expenses are involved. If the MARR = 10% per year, show which alternative is more desirable using equivalent worth methods. Use the repeatability assumption. Alternative A Capital investment Annual cash flow Useful life (years) Market value at end of useful life Solution by the PW method: PW(10%)A =-$3,500 - $3,500 [(P/F,10%,4)+(P/F,10%,8)]+($1,255)(P/A,10%,12) = $1,028 PW(10%)B =-$5,000 - $5,000(P/F,10%,6) + ($1,480)(P/A,10%,12) = $2,262 Based on the PW method, we would select Alternative B because it has the larger value ($2,262) Solution by the AW Method: (1.) The AW of each alternative over the 12-year analysis period based on the previous PW values. AW(10%)A = $1,028(A/P,10%,12) = $151 AW(10%)B = $2,262(A/P,10%,12) = $332 (2) Determining the AW of each alternative over one useful life cycle. AW(10%)A = -$3,500 (A/P,10%,4) + ($1,255) = $151 AW(10%)B = -$5,000(A/P,10%,6) = $332 When the repeatability assumption is applied, simply compare the AW amounts of each alternative over its own useful life and select the alternative that maximizes AW. So we would select Alternative B because it has the larger value ($332). $3,500 1,255 4 0 Alternative B $5,000 1,480 6 0

What if the study period is not a common multiple of the alternative lives or repeatability is not applicable? Use coterminated assumption!

CASE 2: USEFUL LIVES ARE DIFFERENT AMONG THE ALTERNATIVES


2.) THE COTERMINATED ASSUMPTION EXAMPLE: Suppose that (example) is modified to 6 years instead of 12 years. Suppose that the responsible manager did not agree with Repeatability Assumption and wanted 6 years analysis period. Solution: FW(10%)A = [-$3,500(F/P,10%,4)+($1,255)(F/A,10%,4)](F/P,10%,2) = $847 FW(10%)B = -$5,000 (F/P,10%,6)+($1,480)(F/A,10%,6) = $2,561 Based on the FW of each alternative at the end of the six-year study period, we would select Alternative B because it has the larger value ($2,561).

Study Period > Useful Life Procedure: The cash flows of the alternatives need to be adjusted to terminate at the end of the study period. Cost alternatives: Assuming repeatability, repeat part of the useful life of the original alternative, and then use an estimated MV to truncate it at the end of the study period. Without repeatability, we must purchase/lease the service/asset for the remaining years. Investment alternatives: Assume all cash flows will be reinvested at the MARR to the end of the study period (i.e., calculate FW at end of useful life and move this to the end of the study period using the MARR). Study Period < Useful Life When the study period is explicitly stated to be shorter than the useful life, use the cotermination assumption. Procedure: The cash flows of the alternatives need to be adjusted to terminate at the end of the study period. Truncate the alternative at the end of the study period using an estimated Market Value.